The battle for euro-zone reforms

Angela all alone

MAYBE it is the strongest sign that Europe’s leaders think the worst of the euro-zone crisis is over. For nearly four years Angela Merkel, the German chancellor, has been all-dominant in Europe. But at this week’s EU summit in Brussels she ran into an almost unified wall of opposition - from both creditor and debtor countries alike - against her idea of introducing “contracts” to promote economic reforms. Rub your eyes; this does not happen often in European politics. Usually it is Germany - not the rest of Europe - that says nein.

“Millimetre by millimetre we will make progress. But I agree, it’s only a millimetre,” said an exasperated Mrs Merkel at the end of difficult summit dinner on December 19th.

Germany pushed the idea that countries should sign binding contracts with European institutions on a programme of reforms, in exchange for additional economic help. Northern hawks* like the Netherlands and Finland were adamantly opposed to additional transfers, fearing they might become permanent. Southern doves rejected the idea of yet more surveillance and reforms imposed from Brussels, especially if the “solidarity mechanism” offered only paltry sums.

The result was a “negative coalition” of the rival camps who opposed the German idea for diametrically opposed reasons, said another senior EU source.

A major factor was that many leaders feared the unpopularity of the move would feed the rise of anti-establishment, anti-EU and anti-immigrant parties in May’s European election. So the idea of contracts, repeatedly pushed off since autumn of 2012, has been postponed yet again, to October 2014. “The cadaver is still moving but we will have to wait for a better time to revive it,” says one well-placed European official.

Without the fear of an acute crisis that might endanger the euro, nobody was in a rush to abide by Germany’s wishes. In the past, countries desperate for Germany’s financial backing quickly agreed to two separate rounds of treaty change, which they almost unanimously felt were unnecessary, to satisfy Mrs Merkel’s wish to placate the judges of the German constitutional court.

For Germany, the problems of the euro zone ultimately stem from the loss of export competitiveness, particularly in the countries of the periphery that allowed wages to outrun productivity. Its prescription is structural reforms to liberalise labour and product markets, and to promote growth.

But it has proven difficult in the extreme to get countries to change their ways, not least because the structure of economies is a matter to member-states, not European institutions.

Voluntary initiatives, starting with the Lisbon Agenda that sought to make of Europe “the most competitive and dynamic knowledge-based economy in the world” by 2010, and the follow-on Europe 2020 strategy, were long on words and short on real achievements.

The Euro Plus Pact of early 2010, whereby countries would make voluntary pledges that would be reviewed yearly by peers, came as a response to the crisis but quickly disappeared. The commission’s “country-specific recommendations” are now an annual fixture but are little heeded. France, for instance, said the commission should not “dictate” the shape of reforms.

For all the denunciation of austerity, governments have find it easier to cut deficits (too often by raising taxes rather reducing spending) than to address the rigidities of the labour and product markets that hold back growth and, in the case of the euro zone, reduce the flexibility needed to survive within the constraints of a common currency.

In a commentary in the Financial Times today, Mario Monti, the former Italian prime minister, offered two explanations for reform-aversion. First, structural reforms run into organised opposition from groups that enjoy handsme rents (say, taxi drivers who restrict those access to taxi licences). Raising taxes causes only generalised grumbling. Second, European rules focus primarily on controlling debt and deficits, rather than on the underlying workings of the economy. He wrote:

Ultimately, this boils down to a simple rule of thumb: if you meet stronger opposition to structural reforms domestically, and receive less of a push from Europe on this than on budgetary consolidation, the likelihood is that you will make less progress on structural reforms.

In the autumn of 2012 two factors came together. First, there was Germany’s perennial pressure structural reforms, even if it meant re-opening the treaty to make economic co-ordination more binding. Second, France wanted the creation of a "fiscal capacity" - euro-zone budget - to act as a tool of macro-economic stabilisation, for instance by topping up benefits for the short-term unemployed (see my column)

By the end of 2012 the only thing that survived was a thin compromise: countries could, more or less voluntarily, reach “contractual arrangements” with Brussels institutions on a programme of reforms that would be financed by transfers, in the hope of increasing “ownership”. Both sides saw it as a child’s footstep towards their ultimate goal. (see my post here)

As the months have passed, though, both of these elements have been further weakened. The summit communique seeks to bridge the gap between those who wanted “binding” contracts and those who wanted them to be “voluntary”. It now speaks of “mutually agreed contractual arrangements”.

And the associated “solidarity mechanisms”, say officials, are now more likely to be loans than grants; indeed they may just be some form of loan guarantee designed to hold down borrowing costs. Tellingly, François Hollande, the French president, now speaks of "financial capacity", not a fiscal capacity, which would not be a separate budget. The mass of official verbiage, packed with caveats, is an indication of how difficult the discussion has proven to be (wonks will find it in pages 17-20 of the official conclusions).

For better or worse, the countries that have enacted the greatest reforms are those that have been forced to seek bailouts. Mariano Rajoy, the Spanish prime minister, opposed the contracts but was clear that nobody could accuse Spain of failing to reform.

So the contracts are really aimed at vulnerable countries that have not come under official programmes: principally France and Italy. Fate has ensured that the task of resolving the thorny issue in October must fall to Italy, which will take over the rotating presidency of EU ministerial meetings in the second half of 2014. All that Enrico Letta, the Italian prime minister, would say was that “the time was not right”.

The rejection is particularly galling given that Germany had just taken an important, but insufficient, step to set up a banking union (see my column). Will Mrs Merkel now block banking union (it is supposed to be completed by May)? Probably not, say senior EU officials; it is too important to become a hostage of tactical games. Mrs Merkel might need only to play a waiting game: sooner or later somebody will want Germany to commit more money to stabililse the euro zone, and then Mrs Merkel will hold up a nice contract for everybody to sign.

* A reader kindly reminds me that my previous reference to the Netherlands and Finland as "surplus" countries is no longer true.

The reason you are losing your industries and jobs is not Germany, nor the EUR. It is the inflexible labor laws and the high taxation.
Also your low level argument and analysis is shown at the usage of the word "poodles" to describe Austria, Holland and Finland. Those countries and Germany are usually on the same side because they are the countries from which sacrifices are required.

The main reason Germany has such a strong export economy is the fact that they are in the Eurozone. If Germany left, they would suddenly lose their cheap currency that is currently devalued by the rest of Europe and would lose almost all of its customers to the US, who have the same productivity with considerably lower operating/manufacturing costs. And lower-end manufacturing would all go to Asia.

Everyone is pretending the Germans are hapless idiots being manipulated into paying for lazy peoples' lifestyles, but they are forgetting that those lazy peoples' lifestyles are the main reason Germany is doing so well economically. This is precisely why the German government has been so willing to hand out money -- the alternative is the breakup of the EZ and economic catastrophe for Germany.

No European country can compete with the US when it comes to manufacturing without some sort of structural advantage. Energy, labor, and land are all cheaper in America and there is a much larger labor market with similar skills and productivity, along with lower taxes and the world's largest market. Germany is not stupid.

The difference between you and me is that YOU have no clue about the economic structure you are talking about. Don't take it personally, but that's exactly the reason why I read your comments for "entertainment purpose" and also possibly why LV doesn't comment (as he seems to be interested in a serious discussion).
There are highly competitive industries in northern Italy and not few of them are competitors to Bavarian businesses, but even more both economies are also highly interconnected using intermediate goods from each other (core pro-€ argument: lowering exchange risks).
However, did you know that many of the owner of these mostly small and medium sized companies and their associations (BVMW, BJU, even former president of BVI) are the loudest critics of the "euro rescue policy" (demanding parallel currencies in Euro and exit of incapable countries from the Euro)?
They don't fear the competition, but to bear the consequences of these policies.

Regarding the "Bavarian fear of uncompetitive milk prices" (laughs), have you ever heard of the European milk quotas?
Further on, especially Germany has an extremely high competition in the retail market offering low margins for producers and low prices for consumers. The consequences are e.g. milk prices for consumers that are nearly twice as high in Italy as in Bavaria. BTW Bavarian producers are selling their milk to Italy.
But hey, I am still interested in a "Mickey Mouse" article "proving" the opposite...

You are probably right about stereotyping: my remark was a sample of lazy thinking, so I withdraw and apologize. I have certainly no prejudice about Italians or Portuguese, all my criticism is aimed at your political elite... actually, any political elite... and EU bureaucracy.
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Felini... hm, Eco is more to my liking as a source of "anthropological" data about Italy.

Stereotypes are in force everywhere!
Italian way of life is not and probably has never been a sort of Fellini's "dolce vita". I have no data, but I bet that the working hours of technical and manual workers in Italy are appreciably more than most of our major European "partners".
As for research and university, we have approximately half of people engaged in this sector compared to Germany, but output in terms of citable papers are comparable. Are Italians lazy by genetics or have you a prejudice about Southern Europeans?

Funny you say that remember that the Maastricht rules were watered down by Germany and France to allow them to breach the 3% deficit rule year after year. Now Germany has finally lowered hers then suddenly everybody should follow the rules of the book… When Germany's economy goes back to being the sick man of Europe (it still is only the others are currently worse off because growing 1 year 3% doesn't suddenly make your economy booming, as last two years of low growth have shown), we shall see how they will go back to the usual -ignoring the Maastricht rules.